AGEC 429: AGRICULTURAL POLICY LECTURE 10: GENERAL POLICY INSTRUMENTS I

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1 AGEC 429: AGRICULTURAL POLICY LECTURE 10: GENERAL POLICY INSTRUMENTS I

2 AGEC 429 Lecture #10 GENERAL INSTRUMENTS OF FARM POLICY I General Policy Instruments That We Will Focus On: 1. Price Support Policies Government Surplus Purchase Program Demand Expansion Programs Supply Control Programs 2. Revenue/Income Support Policies Coupled Payments Decoupled Payments 3. Revenue/Income Stabilization Policies Crop Insurance General Format for Discussion of Instruments: 1. What is it and how does it work? 2. What are the market effects (output market, input market, cross-market) 3. Who gains and who loses from the policy?

3 PRICE SUPPORT THROUGH A GOVERNMENT SURPLUS PURCHASE PROGRAM 1. WHAT IS IT AND HOW DOES IT WORK? - Government first determines if the market price is too low and, if so, sets a higher level. - To make sure that the announced support price is achieved, the government purchases supply off the market until the price rises to the announced. - As price rises, quantity demanded by consumers declines and quantity supplied by producers increases. - The between the quantity supplied and quantity demanded at the support price is how much the government must buy off the market to achieve the level of price support desired. - Many ways of making this happen. Minimum price procurement programs in many countries Non-Recourse Loan Program in the U.S.

4 NON-RECOURSE LOAN PROGRAM (1) Farmers pledge crop as collateral for a loan from the Commodity Credit Corporation (CCC) of the USDA (2) Loans made at fixed rate per unit of expected output (the Loan Rate ) Example: 10,000 bu. Wheat expected production If Loan Rate = $3.30/bu, then Loan = (3) Loans made without recourse: - Farmers have the option of: (1) Selling their crop and paying off the loan (plus interest) within 9 months, or (2) Defaulting on loan and letting CCC take their crop as payment - CCC must accept the crop as even if the market value of the crop is less than the loan amount! (The CCC has no recourse but to accept the crop as full payment.) - In essence, the CCC buys the crop from farmers whenever market price drops below the loan rate! (4) If farmers hold on to their harvested crop until re-payment is due (and then either re-pay or default on their loans), they must pay any.

5 2. WHAT ARE THE MARKET EFFECTS OF A GSP PROGRAM? - Market effects of a general GSP program P S The government first sets P L above the equilibrium price (Pm) and producers respond by producing to Q S. With increased supply to Q S, the market price will begin to drop so the government purchases the commodity. P m D until the market price rises to P L which reduces consumer purchases to Q D. The total government purchase will be the difference between the quantity supplied and the quantity demanded at P L. Q m Q How does the government know how much it will have to purchase off the market? Would it help for them to know the elasticity of supply and the elasticity of demand? (Hint: )

6 2. MARKET EFFECTS OF A GSP PROGRAM (continued) - The loan rate is intended to support price. Market effects of a NR Loan program: Two Possibilities 1. Farmers 2. Farmers P Government Purchase S P D S P L P m P m P L D Q D Q m Q S Q Q L Q m Q 1. Farmers take out CCC loans at P L (loan rate).. 2. Farmers default on the loans (don t pay back them back) because P m < P L. 3. As defaults occur, government takes over crop (puts it in storage) and P m begins to rise. 4. When P m reaches P L, then farmers stop defaulting on loans and the government stops taking over crops. 1. In this case, P L is set below P M ( safety net ) 2. Again, farmers take out CCC loans at P L (loan rate).. 3. But in this case farmers sell their crop at P m, pay off their loans and keep the rest. 4. NR loan program simply acts as a means of giving a production loan to farmers.

7 2. MARKET EFFECTS OF A GSP PROGRAM (continued) - NR loan program: (1) Provides a ready source of production financing for farmers. (2) Reduces down-side price risk (i.e., acts as a price floor). (3) Smoothes out marketings. - See Summary Sheet (next page)

8 WORKSHEET GENERAL POLICY INSTRUMENTS AND THEIR EFFECTS Assume the supported commodity is a feedgrain Variables Domestic Supply Domestic Consumption Exports Farm Price Farm Income Consumer Price Export Price Livestock Number Price Cost Consumer Gov t (taxpayer) Net Society Effects GOVERNMENT SURPLUS PURCHASE PRICE SUPPORT DEMAND EXPANSION SUPPLY CONTROL INSTRUMENTS REVENUE SUPPORT COUPLED DECOUPLED REVENUE STABILIZATION CROP INSURANCE * Assuming that demand is inelastic.

9 WORKSHEET GENERAL POLICY INSTRUMENTS AND THEIR EFFECTS Farm Income = Revenue - Costs P 2 x Q 2 P 1 x Q 1 P 2 x Q 2 P 1 x Q 1 P 2 P 2 P 1 inelastic demand P 1 elastic demand Q 2 Q 1 Q 2 Q 1

10 2. MARKET EFFECTS OF A GSP PROGRAM (continued) - NR loan program: (1) Provides ready source of production financing for farmers (2) Reduces down-side price risk (i.e., acts as a price floor) (3) Smoothes out marketings - See Summary Sheet (next page) - Input Market Effects (The of farm program benefits into the value of farm assets): Two Possible Cases: $/acre Inelastic S input (land) Elastic S input (labor) S Land $/acre P* Land S Labor P Land P* Labor P Labor D* Land D* Labor D Land D Labor Higher prices of farm commodities drives up the demand for and prices of inputs. Benefits of price support capitalized into the value of inputs. (This concept WILL be on the mid-term exam.) - Farm Income Effects: Net Income = Total Revenue Total Cost Both revenue and costs increase. So what happens to farm income?

11 3. WHO GAINS AND WHO LOSES FROM THE POLICY? S P L P e a b e c f d g h D Welfare Conclusions 1. Consumers lose 2. Producers gain 3. Taxpayers lose 4. Income is transferred from consumers and taxpayers to producers 5. National Welfare loss (Deadweight Loss (DWL) of shaded area) Q D Q e Q S With Program Without Program = CHANGE CS + PS = Subtotal - Gov t Cost = Net Society Effects (NSE)